Time’s up: Is your not-for-profit tax reform ready?

With tax reform now signed into law and the differences between the competing versions of the House and Senate tax bills resolved, it is important for not-for-profit organizations and higher education institutions to understand those provisions of the law that impact them – both directly and indirectly. Understanding the changes will allow organizations to take timely actions to comply with the new laws and minimize the tax and administrative burdens. Following is a summary of pertinent changes that may impact your organization:

Unrelated business income (UBI). Tax reform legislation tackled unrelated business income in several ways:

Initial proposals sought to remove the exclusion for passive royalties [name, logo, trademark], thus treating all revenues derived from royalties as unrelated business income. This provision did not make its way into the final bill.

Unrelated business income (for those entities created as corporations) will be subject to the new corporate income tax rate of 21% (there will be no sliding scale rate based on the amount of UBI generated).

Tax-exempt organizations will need to treat each unrelated trade or business activity as a separate line of business, effectively creating a separate profit and loss statement for each activity. The losses from one unrelated trade or business cannot offset the gains from another. This treatment places tax-exempt entities at a disadvantage to their for-profit counterparts which may offset profitable lines of business with unprofitable ones.

If a tax-exempt organization provides certain fringe benefits to its employees, (such as subsidized parking, transportation or on-premises gyms), the value of the benefits must be treated as unrelated business income on the Form 990-T if the benefit is not treated as taxable wages to the employee.

Net operating loss carryforwards (NOLs) have been modified (aligned with the corporate rules). NOLs are limited to 80% of taxable income. NOLs can no longer be carried back to prior years, but may be carried forward indefinitely.

Tax-exempt organizations (set up as a corporation) do not need to compute Alternative Minimum Tax (AMT) on their UBI tax activities.

Grant Thornton Perspective: Organizations with unrelated business income need to plan for the above changes, determine if estimated taxes must now be paid and come to internal decisions about whether to change the employee benefits that may be offered and would now be subject to a 21% tax on the organization if not treated as taxable compensation to the employee. Careful consideration to expense allocations, especially as it relates to multiple activities is also an important step that must not be overlooked, so that all indirect costs are fully allocated.

Excise tax on excess compensation. The new tax reform bill does not make any changes to the Intermediate Sanctions rules as was initially proposed; however, the provision to assess a 21% excise tax on compensation paid to the top five “covered employees” in excess of $1M (as well as on “excess parachute payments”) remains. Certain employees within the medical profession (doctors, nurses and veterinarians) are excluded from this provision.Grant Thornton Perspective: Organizations must prepare for the increased cost of these compensatory arrangements and should consider revisiting deferred compensation and other contractual arrangements that could help minimize the taxes paid.

Excise tax on college endowments. Private colleges and universities with at least 500 full-time enrolled students and assets greater than $500,000 per student will be subject to a new 1.4% excise tax on their endowment net investment income. It is currently estimated that fewer than 30 colleges within the United States will be impacted by this provision. For purposes of this tax, related organizations with common control or set up as supporting organizations are considered part of the college endowment.

Grant Thornton Perspective: While there remains an uncertainty as to how investment income will be calculated and how to identify the funds it applies to, private colleges affected by this tax, as well as those nearing the applicable triggers for it, should plan for the reduced net endowment income as a result of the added expense. Institutions should also take steps to minimize taxes such as refining the allocation of investment expenses related to the endowment to make sure all applicable expenses are captured. It may also be possible to review the college’s current allocation of financial assets which may result in an increased amount in institutional funds as opposed to setting it aside for the endowment.

Charitable contributions. Changes made to the individual income tax rules could have a profound impact on the not-for-profit community. (Many of the individual tax law changes may expire following 2025).

By increasing the standard deduction and limiting itemized deductions (state and local taxes), the new legislation reduces the number of individuals who will choose to itemize deductions on their personal tax returns. With no tax incentive to make a charitable gift, individuals may ultimately decrease their charitable giving.

The new legislation doubles the exclusion amount for estates and gift tax purposes. Gifts that formerly may have gone to tax-exempt organizations (to avoid the estate tax) may dry up as benefactors leave their wealth to their family tax-free instead.

For those households that still itemize their tax returns, the new legislation increases the percentage limitation on giving to public charities from 50% to 60% of an individual’s adjusted gross income.

Specific to higher education institutions is the removal of the law allowing individuals to deduct, as a charitable contribution, 80% of their payment for the right to purchase tickets or seating at athletic events.

Grant Thornton Perspective: While the true impact of the individual tax law changes on charitable giving are unknown, organizations need to plan for potentially decreased giving, especially from individuals who give less than $10,000 per year as they are more likely to weigh the tax benefit of their giving prior to making a donation. Creating a strategy for dealing with donors who may be less likely to give is critical, and creative planning such as staggering gifts in alternating years might be something individuals would consider. Additionally, many individuals are setting up donor advised funds before December 31, 2017 to take advantage of current laws, yet allow for future giving needs so continued communication with donors can result in giving from those funds instead of the individual directly.

Employment Tax. Several key provisions of the earlier bill versions that would have made certain perks provided to employees taxable were removed from the final legislation, namely employer-provided tuition assistance, taxation of graduate student fellowships, and a proposed limitation on housing provided for the convenience of the employer. Remaining, however, is the removal of qualified moving expenses which will now be taxable as well as clarification/limitations of employee achievement awards.

Grant Thornton Perspective: Much relief is felt with the removal of the tuition and housing proposals while the change in employee achievement awards does not have a profound effect. For organizations that pay moving expenses to recruit someone for a position, a determination will need to be made whether to gross the payment up to make the individual whole on taxes which will add to the overall costs of such recruitment.

Other key legislative changes. While private activity bonds will continue to provide benefits for financing, the ability to use tax-exempt debt to advance refund previously issued bonds has been removed. In addition, institutions with certain foreign interests may be impacted by the one-time transition tax on the repatriation of income as well as the Base Erosion and Anti Abuse Tax on certain taxable income.

Notable exclusions. Many other notable proposals were left out of the final legislation including the “Johnson Amendment” which would have allowed 501(c)(3) organizations to conduct some limited political activities; the 1.4% flat tax on Private Foundation net investment income; disclosure requirements for Donor Advised Funds; elimination of tax-exemption for professional sports leagues; and the removal of New Market Tax Credits.